Australia’s Carbon Tax Will Be Negative for Standalone Coal-Fired Generators

Australia’s Carbon Tax Will Be Negative for Standalone Coal-Fired Generators

As reported in the local media last week, Australia’s state-owned Macquarie Generation, the largest electricity generator in the national electricity market (NEM) by output, advised the New South Wales State government of its weakening performance and forecast an operating loss by fiscal 2014, primarily driven by the July 2012 introduction of Australia’s new carbon tax, higher coal costs and softer electricity demand.

The carbon tax is credit negative for standalone coal-fired generators in the national electricity market. However, we believe its effect on vertically integrated electric utilities, such as Origin Energy (Baa1 negative), will be broadly neutral, given their integrated business model and diversified generation fleets. Around 50% of Origin’s generation capacity comes from the 2,640MW coal-fired Eraring power station in New South Wales.
Compared to the independent coal-fired generators, Australian integrated electric utilities benefit from their diverse portfolio of generation assets across different fuel sources, as well as their dominant market position in the retail electricity market. The top three integrated utilities (i.e., Origin, and the unrated TRUenergy and AGL) together serve over 80% of mass-market retail customers and control around 30% of total generation capacity in the national electricity market, which is composed of coal, gas and renewable power stations.

Ownership of multiple power stations allows integrated utilities to more effectively respond to the effect of the new carbon tax. As the cost of carbon increases, integrated utilities can reduce output from their coal-fired plants and lift generation from less carbon-intensive generators in their fleets. In comparison, independent coal-fired generators have limited capacity to shift away from coal, making their generation revenue more vulnerable to the effects of carbon tax.

The scheduled introduction of carbon tax in July 2012 in Australia would increase the operating cost of carbon-intensive coal-fired generators. Although we believe generators can recover some of the tax via higher wholesale electricity prices, we consider full cost recovery unlikely.
The integrated utilities’ strong position in the retail electricity market is another key driver supporting their ability to manage the cost of carbon. Integrated utilities can use the electricity generated from their power stations to meet the electricity demand of their retail customers. As such, they are better able to sustain marginally more expensive production costs caused by the carbon tax.
In contrast, demand for electricity from independent generators is generally more price sensitive, as their outputs are generally sold to industrial customers, integrated utilities, or on the spot market.

Finally, integrated utility companies have greater financial capacity and benefits from their dominant retail market position to support the construction of new power stations in response to market signals. As carbon cost increases, integrated utilities can respond to declining production from their coal-fired generators by constructing new and less carbon-intensive power stations to replace lost output. It is more difficult for independent coal-fired generators to undertake such greenfield developments given their already weakening financial profiles and the lack of a retail customer base to ensure demand for the new facility.